Swedish CPI is immediately affected by rate hikes as flexible mortgage costs are impacted (currently 70% of mortgages are running at flexible rate).
Markets have sold off recently and current market pricing suggests a hiking cycle starting next year, which is a little earlier than expected by the Riksbank, but roughly in line with the repo rate path, see Chart 1.
These hikes are not reflected in short-end break-even inflation spreads. Higher flexible mortgage costs will have unprecedented impact on shorter BEIs. A fact the market seems to ignore.
As market pricing is close to the Riksbank's rate path we can use their calculation/estimation of the mortgage cost effect, see Chart 2. Doing this exercise shows that the 3Y BEI (BEI3102) trades the cheapest along the BEI curve.
The Riksbank's calculation seems conservative to us as 110bp of rate hikes over three years results in an average effect of 0.53% in CPI, i.e. 0.1-0.15% per 25bp rate hike (we estimate a 25bp rate hike - if translated fully into 25bp higher flexible mortgage costs could add up to 0.4p.p. to CPI). One reason for the moderate estimation could be that Riksbank does not expect banks to follow rate hikes in a 1:1 fashion.
Doing the math, starting with BEI3102 currently at 1.75%, means that market pricing implies an average CPIF over the next three years at1.25% (BEI3102 in CPIF terms). This is the lowest point along the forward BEI (CPIF) curve, and not consistent with the hiking cycle priced.
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